In 2003, the Pentagon nearly created a terrorism prediction market.
money.cnn.com
money.cnn.com
For instance, one of the new trends in prediction markets has been corporate elicitation (e.g., Inkling Markets YC W06). For instance, a market might ask a pool of employees "When will product X ship?". Now consider the employee's problem. He knows the product will be delayed until November at the current pace, but that if managers see high November probabilities they'll cut back on the project and re-focus development efforts (or, perhaps instead, shift some staffers over to get the project done faster). How should the employee trade in this market?
If your answer is "it's unclear" then you're exactly right. The self-referentiality of prices (they cause actions which then define prices) makes the problem much harder. It's actually possible to design markets which are so self-referential that any trade will be the right one (the market prices are self-predicting prophecies) or that any trade will be the wrong one (e.g., if there's a high price on terrorist attack Z then the government will always spend enough money to prevent Z from happening).
In fact, the only way around the paradox is to have the prices in a prediction market not matter at all - for the managers to take the same course of action regardless of the prices they see in the market. But then why run a market in the first place?
The whole thing is an interesting and seemingly fundamental perversion of the way we normally think about prices. And again, this is without any malicious intent on the part of participants, which will certainly only further confuse things.
Without a market, information is disjointed; everybody has some imperfect, incomplete part of the whole picture. Any planner will make irrational plans, he or she is dealing with a minute subset of information.
When the market is for information itself, I'm not sure if Hayek would have much to say. Markets for such things seem like they should be far more fragile. I think stock market volatility in the recent crisis is actually evidence of that.
Incidentally, and ironically, all this technology at our disposal giving us more "freedom", has made the feasibility of central planning more possible. Dys/U-toptian novelists take note.
I am not an economist of Hayek expert, but my understanding is that he address "markets as information" as being markets. Even gambling markets and futures markets, which are both classes of prediction markets generally, are actually information markets even though they are ostensibly about goods or events.
I agree and disagree about your characterisation of technology. While yes, computers make authoritarianism more tractable, I don't think they can completely solve the calculation problem.
Suppose you use Leontiev input-output matrices to do your central planning. Matrix multiplication is an O(n^3) problem (I've been told by a mathematician that it can be done in n^2.75 with some tricks). If we take GDP growth as a proxy for the number of matrices required, it would need to be kept below a few percent or it would outstrip Moore's law in the long run. And that's ignoring the problem of populating the matrices in the first place.
FWIW, I host an economics blogger in Australia, Dr Nicholas Gruen, who has proposed to reduce market volatility by requiring blind clearances on a once-per-minute basis.
For one, the people typically participating in a question like ship dates are not just from the project team, but from other roles as well, i.e. people who will be involved in marketing the product, selling the product, engineers who work on similar products, etc. These people have less of a direct interest in the outcome vs. simply expressing what they think is going to happen. So diversity of participation by role is pretty key.
Your point about self-fulfilling prophecy is also something we get asked about regularly. In practice, the market is available to trade 24/7 until the outcome is known. So going through your scenario, let's say the market is showing a really high likelihood something is going to ship late. Management decides to mitigate that risk by putting more people on the project. Well the market is still open, so if no one actually thinks putting more people on the project is going to do a damn thing, then the likelihood of being late will remain high in the market. Or maybe those people just got pulled from another project so now that project is in jeopardy. Well the market would hopefully begin to reflect that and when the answer is known everyone will be judged on whether they were right or not.
So ideally if your marketplace is setup correctly and people are actively participating, you're getting all this realtime feedback about what people think is going to happen AND you can even see what people think will happen in reaction to the management decisions you're making. Usually an employee wants management to know something is screwed up without having to stand up and say it to their face in a status meeting.
Also in your scenario you're assuming management is making decisions based on the prediction market alone. I've never seen this - instead it's one factor they consider among others. Despite my belief in the value of prediction markets, I also believe in management being able to make independent decisions. Prediction markets are just a simple and systematic way to get human input from those who have different perspectives.
Then the media got hold of the story and people raised all the objections I had heard before, but the explanations couldn't fit into single sentence sound bites so they never made it into the news.
Nothing quite makes you feel quite so connected to the national legislative process as seeing your project roundly condemned on the floor of Congress ;)
If you are able to comment on this, what were the underlying pricing mechanics of the market? How were new securities going to be created? Heh, to think that simulated stock market software might be classified...
The main securities in the market were 5 statistics that we were tracking quarterly in 8 different Mid-East countries (things like civil stability, military activity, US aid, etc). Then there were supposed to be a handful of one-off type events; we hadn't decided on them yet, but gave some "ripped from the headlines" examples that were the main focus of the criticism. The values of all these securities were to be judged by the Economist Intelligence Unit.
Many of the individual projects continued forward or have since resurfaced. They just have better logos and acronyms now.
The importance of that rule was demonstrated in the recent financial meltdown, as AIG was unable to pay all the claims of people who took out "insurance" on collateralized debt obligations they didn't own.
In a futures market, people betting on events occurring within a given time frame have their interests closely aligned with allowing or encouraging those events to occur. Even if you restrict it to carefully qualified security analysts who you're confident aren't backing terrorists, a prediction market financially incentivises them to withhold any intel they've obtained or observations they've made[2] that might disrupt terrorists' original plans.
[1]Unless you're trying to commit insurance fraud by staging attacks on your own overvalued property. No system is without weaknesses. [2]If there isn't any information asymmetry in their favour then there's no expectation of profit
When you put it that way, I feel stupid. :-)
Oh. Phew. Now I know that only seasoned banking/finance professionals are involved I feel completely safe! Those guys never do any crazy shit!
EDIT: do you mean security experts or securities experts?
Yes.
http://www.amazon.com/Watchers-Rise-Americas-Surveillance-St...
DARPA, in an effort to offset the money wasted on this research, will pivot and attempt to sell this idea (and its obvious potential pitfalls) to the writers of 24 for the next series.
This too is one of the common under-informed criticisms.
How do you make a bet on a long-term trend? What kind of long-term trends? Political events?
-- http://hanson.gmu.edu/realterf.pdf
(Hm, how would one estimate things like economic growth? That sounds really hard and my imagination just fails to think of any way to measure a long-term trend like that!)
> "Our focused later narrowed to a smaller region, the Mideast, because the Economist Intelligence Unit charged a high price to judge after the fact what instability had actually occurred in each nation. The final plan was to cover eight nations. For each nation in each quarter of a year (over the two year final phase), traders would estimate five parameters: its military activity, political instability, economic growth, US military activity, and US financial involvement. In addition traders would predict US GDP, world trade, US military casualties, and western terrorist casualties, and a few miscellaneous items, to be determined by traders and the EIU. This would require (8 × 8 × 5 =) a hundred or so base markets. > > In addition, we planned to let traders predict combinations of these events, such has how moving US troops out of Saudi Arabia would effect political stability there, how that would effect stability in neighboring nations, and how all that might change oil prices. Similar trades could have predicted the local and global consequences of invading Iraq, had such markets been ready then. (More on this in the later section on combinatorics section.)"
It's kind of a cool idea but seriously?
--philosopher David Lewis (1973)
The US Government has already sold the livelihood of most of its people (ie. industry) under the guise of the free market. Talk to someone who grew up in Buffalo, Cleveland or any number of places in Michigan and they'll tell you all about it.
Letting people make money off of betting on you getting blown up is just a more offensive way of getting rich on the backs of others.
The suggestion that I am ‘some sort of communist’ does make me chuckle though :)
The Policy Analysis Market was designed to allow registered traders (it was going to start as a market open only to select analysts, experts) to make money-backed predictions. That is, putting your money where you mouth is. It's a tool to filter noise and focus analysis, not fuel hedge funds.